How to set up a joint venture with a contractor who has minimum capital?

General Real Estate Investing
1

A general contractor who I have some previous dealings would like to start investing in real estate with me. My question is, if I were to put up the cash for the purchase and he were to supply the labor and material, how would we split the proceeds when we sell?

There are some preliminary guidelines for our joint venture that we have discussed:

  1. We will be investing in a single family house (under $100,000), most likely a foreclosure under $100K that needs rehab. Once it is rehabbed we are planning to hold it for a few years as a rental so it is not going to be a flip.

  2. We will set up an LLC before acquiring the property.

  3. I will be putting up 100% of the cash for the purchase (no financing needed.)

  4. He will be contributing the labor (and maybe the cost of the materials) to get the property in rent ready condition.

  5. He will do the majority of the management, especially repairs, once the property is rented.

My question is how should the equity position (as well as the potential cash flow) be divided? Should it be fixed split throughout the entire holding period (say 80/20), or should it be adjusted after he has contributed more and more capital (cash and labor)?

Thanks.

2

The equity position and cash flow can be divided however the two of you feel is fair. I would put a dollar value on his labor and he can cash out according to how much he puts in. You get paid based on your investment and rate of return.

You and your partner first work out the details between the two of you. Then, hire an attorney who specializes in drafting partnership agreements. Don’t assume anything. Write it all down before you two start investing together and don’t use some free or low cost service. Sit with someone to draft a proper document. Your situation is not the assumed one used in the standard forms and you will find yourself litigating the dispute when something goes wrong. It will cost much more than what you will pay to have it done now.

Check out a limited liability partnership. It can be cheaper than an LLC and has the same benefits.

3

Thanks for the respond.

I will let a lawyer take care fo the legal stuff.

After giving it some thought I have come up with a formula for profit sharing:

Let’s say my partner (the contractor) and I buy a house for $100,000 including cost of fixing the property (e.g., $90,000 is the purchase price and $10,000 in material to fix it up to rentable condition). I will contribute the whole $100,000 in cash and we will come up with a mutually agreeable amount for his labor (e.g. $5,000). So in this case I have made a $100,000 investment and he $5,000 (not cash but sweat equity).

Since we are looking to hold this for a long term (at least 5 years) until the market turns to sell it we are keeping it as a rental during that period. Let’s say we will get $1,000 per month in rent and the average monthly fixed expenses are as follows:

Property Tax: $100
Insurance: $50
Utilities (water/sewer/trash): $150
Maintenance/Repairs: $50 (remember the house will be completely rehabbed)
Replacement: $50
Miscellaneous: $50
Vacancy allowance (5%): $50

So we should net $500 per month (the are no loan payments to make so I think this positive cash flow is realistic).

I think it is fair to divide the $500 this way: For my initial $100,000 investment I want a 3% “guarantee” return so it works out to be $250 per month. If his initial $5,000 he should get 3% also = $12.50. After we subtract the “guaranteed” return portions for both parties we will divide the remainder 50/50.

Now when we sell the property we will calculate the profit sharing in the same manner but probably at a different “guaranteed” return rate.

Say we sell the house a 5 years later and after all the closing costs we will net $165,000 so there is a $60,000 net profit after I get back my initial investment of $100,000 and his of $5,000. I would propose a “guaranteed” return of 10% for the initial investment so my “guaranteed” portion using simple interest would be $50,000 ($10,000 x 5 years) and his would be $2,500 ($500 x 5 years). We will subtract the guaranteed return portion of $52,500 from $60,000 and divide the rest 50/50.

I think my partner should be happy with this arrangement because he would get more than $10,000 in 5 years (this does not even counting the monthly cash flow portion) from basically nothing but his initial sweat equity.

Of course we have to divide the management responsibilities during our holding period but that detail can be worked out.